Deloitte & Touche Class Action Defense Case-Lattanzio v. Deloitte: Second Circuit Affirms Dismissal of Securities Class Action Against Outside Accountant

Feb 5, 2007 | By: Michael J. Hassen

Second Circuit Holds that District Court Properly Granted Defense Motion to Dismiss Securities Class Action Against Outside Accountant Because (1) Claims fell Outside Class Period, (2) Accountant is under no Duty to Correct Financial Statement for which it Provided no Public Opinion, and (3) Plaintiffs’ Failed to Adequately Allege Loss Causation

Plaintiffs filed a putative securities class action against Deloitte & Touche in its capacity as outside accountant for Warnaco Group for violations of Section 10(b) of the Securities Exchange Act of 1924 and Rule 10b-5 alleging that Deloitte misstated Warnaco’s financial condition and breached its duty to correct previous misstatements once it learned that they were inaccurate. Lattanzio v. Deloitte & Touche LLP, 476 F.3d 147, 2007 WL 259877, *1 (2d Cir. January 31, 2007). Defense attorneys moved to dismiss the class action under Rule 12(b)(6). The district court granted the motion finding that “[i] Deloitte was not liable for Warnaco’s quarterly statements, which it did not audit; [ii] Deloitte had no duty during the class period to correct statements or misstatements made by Deloitte prior to the class period; and [iii] Plaintiffs inadequately alleged loss causation in connection with the statements that Deloitte made during the class period.” Id. On appeal, the Second Circuit affirmed the “thorough and well-reasoned opinion” of the district court. Id.

Deloitte began serving as Warnaco’s outside accountant in November 1999. Plaintiffs filed this class action after Warnaco declared bankruptcy in June 11, 2001 seeking to represent those who purchased Warnaco’s common stock from August 15, 2000 through June 8, 2001 (defined as “the Class Period”). Lattanzio, at *1. The class action complaint alleged that Warnaco’s 1999 Form 10-K (filed in March 2000) overstated total shareholder equity by $30 million, and that in February 2000 Deloitte learned of $26 million of this sum but did not correct Warnaco’s financial statements until March 2001. Id. Deloitte allegedly learned of the additional $4 million mistake “sometime in fall 2000” but did not correct the financial statements until August 2001 (by which time Warnaco was in bankruptcy). Id., at *2. The complaint also complained that the three quarterly statements Warnaco filed during the Class Period contained material misstatements; Deloitte did not audit these statements but “reviewed” them as required by federal law and, allegedly, learned of the errors but failed to correct them. Id. Finally, the complaint alleged that Warnaco’s 2000 Form 10-K contained material misstatements Id., at *3. However, Deloitte’s audit opinion expressed a “going concern” that the company “was not in compliance with certain covenants of its long-term debt agreements” and that the company “was a working capital deficiency as of December 30, 2000” which “raise substantial doubt about its ability to continue as a going concern.” Id. As noted above, the district court granted the defense Rule 12(b)(6) motion and dismissed the class action complaint.

In analyzing the district court’s order, the Second Circuit agreed with defense attorneys that the claims regarding the 1999 10-K were outside the Class Period because the last such form was filed in May 2000. Lattanzio, at *4. As for plaintiffs’ argument that Deloitte learned of the $4 million error during the Class Period, the Circuit Court found it unnecessary to consider whether “Deloitte’s failure to correct the 1999 10-K in fall 2000 was a statement for purposes of § 10(b) and Rule 10b-5 because … plaintiffs have insufficiently alleged that these errors caused their loss.” Id.

With respect to the quarterly statements, which Deloitte did not audit, the Second Circuit rejected plaintiffs’ argument that “Deloitte’s regulatory obligation to review Warnaco’s quarterly statements entails a duty to correct,” Lattanzio, at *5. The Circuit Court held that “the existence of a duty to correct cannot by itself translate Deloitte’s silence regarding the 10-Qs into an actionable misstatement” because an accountant is under a duty to correct only those financial statements that it audited. Id. (citations omitted). Plaintiffs raised several creative arguments in an effort to hold Deloitte liable for Warnaco’s misstatements, but the Second Circuit rejected each of them. See id., at *5-*7. The Circuit Court’s reluctance to expand securities fraud liability may be explained by the following quote: “The private right of action under § 10(b) and Rule 10b-5 is a ‘judicial oak which has grown from little more than a legislative acorn.’ … ‘It is inconsistent with settled methodology in § 10(b) cases to extend liability beyond the scope of conduct prohibited by the statutory text.’” Id., at *6 (citations omitted).

Finally, as to the 200 10-K statement audited by Deloitte, the Second Circuit concluded that the class action complaint adequately alleged misstatements by Deloitte during the Class Period, but that it failed “[to] allege that these particular misstatements caused their loss.” Lattanzio, at *7. Specifically, the complaint failed to establish a causal connection between the misstatements attributed to Deloitte and the losses suffered by Warnaco’s bankruptcy. Id., at *8. The Circuit Court rejected plaintiffs’ claim that Deloitte concealed the risk of bankruptcy by turning to Deloitte’s audit warning of “going concern”: “In light of Deloitte’s ‘going concern’ warning – and the disclosed (if understated) collapse of value – it was ‘unambiguously apparent’ that Warnaco was in need of desperate measures and faced a risk of bankruptcy.” Id., at *9. The Second Circuit therefore affirmed the district court’s judgment, holding that plaintiffs failed to adequately allege loss causation. Id.

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